March 2015

The last three years have seen the lowest mortgage rates found in decades. With interest rates positioned to rise in 2015, this is a great time to buy a home. Housing prices are still suppressed in many areas, yet trending upward. This provides the perfect storm for buyers to purchase a property at low prices, while enjoying record low interest rates.

It is tempting in this environment to lock into a 30 year fixed rate when the time comes to make your purchase. After all, that is what most borrowers do. Yet this strategy may not get you the lowest possible rate or payment.

Considering that interest rates have such a significant impact on the house payment, evaluating all your loan options will help you get the best deal.

Loan Options

30 Year Fixed Rate Loan will offer the same rate over the entire 30 year loan. The principle and interest will remain the same with only the escrow payment changing from year to year, which covers taxes and insurance. As these costs rise, your escrow payment will increase to accommodate the higher costs.

If you plan to remain in your home for 10 years or longer the 30 year mortgage is a great option.

15 Year Fixed Rate Loan will offer the fastest payoff, but the highest payment. While the interest rate for the 15 year will be lower, because the time period is cut in half the overall payment will be higher.

If you want to retire early and be mortgage free before you retire, then the 15 year loan is the best option. It may require you to purchase a less expensive home, but to live mortgage free after 15 years may be worth the sacrifices.

5/1 ARM is a 5 year adjustable rate mortgage. The rate remains the same for the first 5 years and then will adjust every year afterwards. The ARM is amortized over 30 years with an introductory fixed rate that is significantly lower than the 30 year fixed. The terms on each loan will depend on the lender, but generally the variable rate is tied to either the prime rate or LIBOR rate. When the rates adjust they can go up or down. Generally they can only rise by 1 or 2 points a year and there is a maximum it can rise over the life of the loan, which is commonly 5 points.

If you plan to live in the home 5 years or less, this option will offer the lowest interest rate and the lowest mortgage payment. You have the option of benefiting from the lower payment or purchasing a more expensive home.

7/1 ARM is a 7 year adjustable rate mortgage. This loan will work exactly like the 5 year ARM but gives you 2 more years of a fixed rate before the rate begins to fluctuate annually.

If you are planning on living in your home 7 years or less, this option will offer a lower rate than the 30 year fixed.

A chart to illustrate the monthly payment differences might look something like this:

Loan Type

Interest Rate

Loan Amount

Monthly Principle and Interest Payment

Annual Payments

30 Year Fixed

3.90%

$500,000

$2,358.34

$28,300.08

15 Year Fixed

3.15%

$500,000

$3,489.09

$41,869.08

5/1 ARM

3.22%

$500,000

$2,167.81

$26,013.72

7/1 ARM

3.44%

$500,000

$2,228.51

$26,742.12

Rates are based on current rates at Bankrate.com. They are used for hypothetical purposes only to represent monthly payment differences.

This chart illustrates the annual payment difference between the different loan options. Here the difference between a 30 year fixed and a 5 year ARM is $2,286.36 per year (which is like making an extra payment). This figure adds up to over $10,000 in savings over a 5 year period of time. If you are only going to be in the home for a few years, it is worth considering options outside of the traditional 30 year fixed loans.

Other options like interest only loans can keep the monthly payment down even further but take on a lot more risk as the rates can fluctuate monthly, and negative amortization can occur.

When meeting with a lender, consider all of your loan options. Regardless of the loan program you choose, you can choose to finance with either a fixed or variable rate loan.

Physicians are in the fortunate circumstances that they can generally afford an expensive home as soon as you complete medical school. With your new found income sometimes upwards of $250,000 to $300,000 it can be tempting to buy the most expensive home the bank will lend. This is often a mistake and can lead to financial struggles down the road.

Ask yourself the following questions before deciding how much you want to borrow for a home.

What Do You Need Versus What Do You Want

The age old question of needs versus wants is very relevant when it comes to making a home purchase. While you might want a 5000 square foot home right away, is that more than you need? With a larger home comes higher costs for furnishing the home, higher utility bills, possibly home owner’s association fees, country club fees and other expenses. When deciding how much you want to spend on your housing costs be sure to include all of these figures into the calculations. You might discover that buying a less expensive home is more prudent. It is very tempting to want to keep up with the Jones. Just remember, the Jones are not the ones paying your bills.

What Other Bills and Expenses Do You Have

These bills should take into account student loan payments, credit card bills, car loans and other traditional debt that the bank will consider when qualifying you for a loan. Also consider whether you intend to buy a newer car, or add more debt in the next few years. The home mortgage is a long term expense and any debt added after your home purchase will need to be worked into your budget. Better to do that sooner than later.

How Much Are You Putting Away For Retirement

This is the perfect time to establish a retirement plan, if you have not already done so. Your income has increased significantly and you can build it into your lifestyle. Max out your 401K contribution at work and look into whether you qualify for an IRA account as well. Whether your spouse works or not, there should be a retirement plan set up for them as well. This will help you make the most of your contributions. With so many years of schooling and residency you are getting a later start than many others who went to work after finishing their Bachelors or Master’s degrees. This means higher contributions are needed to get you on track.

Lifestyle Choices

Everyone has different financial goals. Some want a large family, while others want to travel. You might want to spend time volunteering or playing golf. There are no right or wrong answers about what you want to do with your free time. What is important is that you budget for those expenses before you buy a home. This step will provide you with the freedom to do those things you love the most.

Often physicians spend so much time at work that finances get neglected. If you spend a little time now, before making a large financial commitment, it will result in more financial freedom to do the things you enjoy.

There is nothing wrong with putting finances on autopilot. But in order for that to happen some forethought needs to be put into what that looks like. When you have done this you will find you are buying a home you can easily afford and also have the time and finances to pay for other parts of your life.

More and more banks are offering special programs for doctors, giving physicians the ability to receive special treatment and special considerations when it comes time to buy a home. This increased competition will allow you to compare rates and programs to find out which offer is best for your long term needs.

With interest rates expected to start rising this year, now is a good time to buy a home and take advantage of current low interest rates. In many areas of the country home markets are still suppressed and real estate prices have not fully rebound from the 2008 housing crisis. This combination of factors can provide an opportunity for higher levels of appreciation and very low mortgage costs.

Benefits of a Physicians Loan

A physician’s loan can almost appear to be too good to be true. Loans are offered to physicians in residency and practicing physicians. Some programs are extended beyond medical doctors to dentists and other healthcare professionals with a PhD.

The loans offer the use of a contact as opposed to requiring w-2’s or other forms of income verification. Loans can often close 60 to 90 days before you start a new job. Most loans geared towards physicians offer zero or a low down payment of 5 or 10%. No private mortgage insurance or PMI is charged saving you hundreds of dollars in the final monthly payment. Physicians loans also offer benefits for jumbo loans, which typically are $625,000 or higher, but will depend on the region you are purchasing a home. Traditional jumbo loans require larger down payments and higher interest rates. Physicians can gain all of these benefits from banks who are trying to court your business.

What’s in it for the Bank?

Higher Interest Rates, Fees and/or Points. Banks charge more for the benefits a physician’s loan offers, in order to offset the risk. You can choose from a fixed or variable rate and sometimes the bank will offer an interest only option. Compared to convention or FHA mortgages, the rates and/or fees will be higher. Benefits like a lower down payment, no PMI, few or no assets, all equals more risk to the bank that you will be unable to make on time mortgage payments.

What reduces the risk is the history of the profession as a whole. Typically physicians buy larger homes, have higher incomes and eventually have more assets than the average worker. This gives the bank the incentive to gain you as a client early in your career.

Each bank or lender will offer different options for their specific physician’s loan program. It is important to compare the rates, fees and points, along with the benefits being offered to determine which option will best meet your needs.

Long Term Relationship. Physicians are very profitable customers to banks. With higher than average salaries, banks have the ability to provide a wide range of services from checking and savings accounts to retirement and college planning. Banks are interested in more than just giving you a home loan. Many will require you to open a checking account as part of the loan qualification.

This means evaluating more than just the mortgage loan terms. Is this a bank that you want to do business with for other services? Do they provide the financial planning tools that will help you be successful? Many physicians do not dedicate adequate time to managing finances and therefore depend on banks or other institutions to provide these services. Working with a full service bank can be beneficial to both you and the lender, as your business expands and your financial needs increase.

When you are purchasing a home, some physician’s loans offer loan programs that require either zero down or a low down payment. While it is tempting to accept a loan program with the minimum down payment available, there can be a downside to this strategy. If the only way to purchase the home is with the low down payment option, then certainly, this is why the programs are there.

If, however, you have saved up some funds for the purchase of a home, you may find more favorable options available with a larger down payment. Compare the advantages to a larger down payment with the lower down payment options to determine which will provide the lowest overall costs.

Interest Rates

One of the big downsides to a low down payment is generally a higher interest rate. The bank sets rates based on the amount of risk they are carrying on the loan. The lower the down payment, the higher the perceived risk is to the bank. This means that accepting zero down payment or low down payment options will generally result in a higher interest rate over the life of the loan. Be sure to compare all loan programs that you qualify for, not just the ones with the lowest down payment requirements. While you can choose to refinance down the road, you do not know what the market rates will be and the cost of refinancing can be expensive.

Mortgage Insurance

For most home purchases with less than 20% down, mortgage insurance is required on the loan. This is an insurance premium that the buyer pays, which guarantees payment of the loan to the bank, in the event of a default. Generally there is a percentage added to the initial closing costs and then a monthly premium that is incurred each month the loan is outstanding. Some mortgage insurance payments will drop off after you have reached the 20% equity mark, others will remain until the home is sold or refinanced.

Mortgage insurance can run up to a couple hundred dollars each month depending on the initial loan amount and it is added to your mortgage payment. This will impact the loan amount you qualify for and will reduce the cost of the home you are able to purchase. Some physician’s loans will waive the mortgage insurance requirement.

Instant Equity

Not putting a down payment on the home you buy or putting the minimum down could result in the inability to sell your home if you need to move soon after a home purchase. When you sell a home there are seller closing costs that generally run from 8% to 10% of the sales price. A low down payment can result in you needing to pay money at closing in order to sell your house. For this reason it is important to consider how long you think you will be in the home as well as how much you want to put down. The longer you stay in the home the more likely the home will appreciate and you will pay down the mortgage, thus creating equity.

Smaller Monthly Payment or More Expensive Home

A down payment will enable you to either have a smaller monthly payment or can enable you to purchase a more expensive property. This can be exponential when you consider that the interest rate will be lower and the possibility of eliminating the mortgage insurance payment can make a dramatic difference to your monthly payment.

Conclusion

Just because you can purchase a home with a minimum amount down does not mean that you should. Consider your personal circumstances and then evaluate the above factors. This can help you decide how much you want to put down on the home you are trying to purchase. Meeting with a lender and discussing your personal situation can provide good insights about which down payment options will best meet your needs.